Daily FX Market Roundup 05-13-13

How Fed Game Plan Affects FX, Bonds, Equities and Commodities
EUR – ECB Sending a Clear Message to the Market
GBP – Will the RICS Turn Positive for the First Time in Almost 3 Years?
AUD – Parity in the Rearview Mirror
NZD – Hit by Weaker AU and Chinese Data
CAD – Oil and Gold Prices Down 1%
G7 Green Lights Yen Weakness

How Fed Game Plan Affects FX, Bonds, Equities and Commodities

There were a number of stories grabbing financial headlines today but the one that affected currencies, equities, bonds and commodities was the report from noted Fed watcher Jon Hilsenrath on the central bank’s strategy for winding down asset purchases. While it should be no surprise that the Fed is thinking about how to reduce bond purchases and may even have a game plan in place, the article was written and released at the perfect time as investors were itching for confirmation that the Fed is still thinking about reducing stimulus. The U.S. dollar soared at the end of last week after U.S. data showed how the economy and Fed policy is moving in a completely different direction from other major economies. Today’s retail sales report confirms U.S. outperformance and increases the possibility of the central bank varying asset purchases as early as September and at the latest December. The movements that we have seen in the financial markets today is the exact type of reaction that we would expect if the Fed is really serious about reducing stimulus. Tapering asset purchases is good for the dollar, negative for stocks and positive for Treasury yields because it means that the central bank is cutting its support for the bond market and providing breathing room for yields. Over the past week and a half, U.S. 10 year yields have soared from a low of 1.62% to above 1.91%. Since commodities are priced in dollars, policy that would drive the greenback higher is also negative for commodities. This explains why the dollar extended its gains but stocks failed to move higher despite stronger than expected retail sales.

Compared to the forecasted decline of 0.3%, retail sales increased 0.1% in April. The rise may be small but excluding autos and gas, retail sales rose 0.6%, which was the strongest pace of growth this year. The improvement in the labor market and the rise in U.S. equities gave Americans the confidence to spend more on clothing, online purchases, food, drink, electronics and building materials. If anyone felt that consumer spending was the missing component of the recovery, they have less to worry about now that spending turned positive in the first month of the second quarter after contracting 2 out of 3 months in Q1. The fact that retail sales did not decline 2 months in a row is a big relief for the Federal Reserve whose plans for reducing stimulus stands apart from easier monetary policies in other parts of the world. It has also boosted GDP expectations for some economists, which is also positive for the greenback. While no major U.S. economic reports are scheduled for release tomorrow, we expect the dollar to remain bid.

EUR – ECB Sending a Clear Message to the Market

The euro ended the lower against the U.S. dollar but continued to hold above the critical 1.2950 level. As we noted before, there must be a lot of orders and option barriers below this level as the currency pair refuses to move lower despite stronger U.S. data and dovish comments from the ECB. Over the weekend, ECB President Draghi reaffirmed their dovish stance by saying that they are considering buying Asset Backed Securities as an additional way to support lending and stimulate the economy. ECB member Visco also said the central bank is “technically prepared” to introduce negative deposit rates. The central bank is sending a very clear message to the market that they are prepared and willing to increase stimulus if the economy weakens further. Therefore tomorrow’s German ZEW survey and Wednesday’s first quarter GDP reports will be particularly important for the EUR/USD. While the recent ECB rate cut, rise in equities and increase in German industrial production should boost investor confidence and hence the euro, if the ZEW survey surprises to the downside, the currency pair may finally see a sustained break below 1.2950. Even if the data is good, we are skeptical about how long EUR/USD can hold this key level. With the ECB moving towards more stimulus and the Fed less, it should only be a matter of time before 1.2950 in EUR/USD is broken. The reason why 1.2950 is significant is because if the EUR/USD closes below this point, there is no major support for the pair until 1.28.

GBP – Will the RICS Turn Positive for the First Time in Almost 3 Years?

The British pound ended the day lower against the U.S. dollar and euro. No U.K. economic reports were released today but the action will heat up for sterling as the week progresses. Tonight we have the RICS house price balance. The outlook for the housing market is expected to improve as the economists look for the index to turn positive in the month of April. If they are right, it would be the first increase in house prices since June 2010. Meanwhile Wednesday’s Inflation report and employment numbers are the central focus for the pound this week. Based on recent economic reports, the central bank could be slightly more optimistic. In general, the fear of inflation has limited the support for more stimulus and good data would further reduce the chance of easing. The Quarterly Inflation report provides the market with the government’s most up to date economic assessment and their outlook for inflation, which is usually a guide for monetary policy but no specific changes are expected in their GDP and inflation forecasts so this quarter’s release could still be a nonevent for sterling.

AUD – Parity in the Rearview Mirror

All 3 of the commodity currencies weakened against the U.S. dollar today but the largest sell-off was in the AUD, which closed below parity with the greenback for the first time since June 2012. Today’s breakdown in the AUD/USD represents a sustained break for the currency pair and with parity now in the rearview mirror, the next support for AUD/USD will be at 0.9870 where the 200-week SMA lies. The latest move lower was triggered by the combination of softer than expected Chinese data and a decline in business confidence. Given the performance of the global equity market and the recent rate cut by the RBA, business confidence was expected to hold steady and possibly even improve but it dropped below zero for the first time in 6 months. Australian businesses are clearly concerned about the outlook for China’s economy and they have good reasons to be. While Chinese industrial production grew at 9.3% and retail sales growth hit 12.5% in April, both reports fell short of analyst expectations. Also, translating the year over year gains to monthly changes, retail sales grew 0.9% last month compared to 1% in March. This slower pace of growth could weigh on Chinese GDP in the first quarter. New Zealand data was mixed but the NZD/USD weakened on the disappointing Chinese and Australian economic releases. New Zealand house prices grew at a slower pace in April while food prices grew at a faster pace. Retail sales are due for release this evening and given the weakness in credit card spending, we expect slower retail sales growth in Q1. No economic data was released from Canada but the loonie fell alongside oil prices.

G7 Green Lights Yen Weakness

It was a mixed day for the Japanese Yen, which traded lower against the U.S. and Canadian dollars but held steady or strengthened against other major currencies. Over the weekend, G7 Finance Ministers green lighted the sell-off in the Japanese Yen by avoiding criticism of Yen weakness or Abenomics. Their lack of concern can be partially attributed to weakness in their own currencies. For the time being, we are still looking for further gains in USD/JPY especially after the sharp increase in U.S. bond yields. Better than expected U.S. data, new highs in the Nikkei and consistent Japanese demand for foreign bonds should drive USD/JPY to 103. The only reason why it hasn’t happened yet is because weaker Chinese data has fueled demand for safe haven currencies like the USD and JPY. Japan’s domestic goods price index, a measure of inflation is due for release this evening but we don’t expect the report to have a significant impact on the Yen.